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Sunday, 22 April 2018

Dissatisfied With Forecasting? Analyse The Trends Not The Actuals!

I have in recent post mentioned the work that my old friend and Vistage speaker, the late Brian Warners, espoused in the management of a business.

In essence he considered that the conventional budgeting process was invidious and he, as a consequence, invented what he called dynamic budgeting.

This consisted essentially of analysing the regular break even activity compared to invoiced sales in a business, in fact, on a weekly or even daily basis.  It is a prime leadership tool and can be checked in real time.

He considered that a leader should not be concerned with the minutiae of the management accounts but rather should look for the information that can be derived from them in a simplified but relevant format.

I recall a past member of my Vistage CEO peer group who was leading a publicly listed company that he managed essentially on six or so graphs produced for him every month.

In other words, it was the trends that mattered and not the monthly actual numbers.

I am constantly surprised by leaders who react to, say, one month’s activity by comparing it with the same period in the previous year.

This only compares direct performance and it does not take into account any other  factors that may have an effect on how the business performs, typically the weather, general economic activity or even the current morale in the business.

We have to accept that looking backwards at a business is not the best way to predict what is going to happen; certainly not by comparing it with a similar period the year before.

It is interesting but not more than that.

Predicting the future is a dodgy exercise to say the least and our great friend of Vistage, Roger Martin-Fagg, says very sagely that you will be either wrong or lucky.

However there is some value in realising that businesses have momentum and unless something dramatic happens, are likely to continue in much the same way for a while.

Just ask any leader who is absent for a period and then when he/she returns, discovers with chagrin, that the business has gone on in his/her absence much as normal.

It is when some change is experienced that the process breaks down.

How best then to derive meaningful information from current and past performance to enable us to make a forecast that has some meaning?

I am convinced that the momentum theory has value so why not use it to advantage?

Given that any prediction will only have value for, say, three months, there are one or two techniques that may help.

Firstly there is the matter of seasonality. Agriculture based businesses are obviously well aware of this factor but how many leaders in other businesses check to see whether there is a pattern of behaviour in their markets that can affect them?

A simple way is to plot monthly actual sales performance over the past five or so years and overlay the graphs to establish any patterns.

Another very important understanding is to get away from looking at comparable weeks or months and start looking at performance on an annual basis using rolling annual averages for sales, cost of sales, gross margin, fixed costs and net profit together with any other relevant KPIs.

It is the trends in the business performance that matter most.

This will give a more realistic view of the way that the business is performing and smooths out any short term anomalies.

In summary therefore try not to use solely the conventional budget and add the following:

  • Break-even analysis comparing the level of break-even sales with actual plotted regularly and then overlay the average trend using linear regression  (generally available on most spreadsheet software).

  • Seasonality assessment over a period of at least the past five years if possible.

  • Assess the performance of the business using rolling annual averages and linear regression to show real trends.

These relatively simple procedures can add real value to the often sterile forecasting process and hence to the way that the leader manages the business.


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1 comment:

โชติ ธรีะวิท said...

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